What are Structured Notes? An Overview
A Structured Note is a IOU from an investment bank that uses derivatives to create the desired exposure to one or more investments. According to the SEC, while structured notes may enable individual retail investors to participate in investment strategies that are not typically offered to them, these products can be very complex and have significant investment risks.
A Structured Note combines two elements: A bond (that is supposed to protect your principal) typically makes up 80% of the investment, and the rest of your money is put into a derivative.
A derivative is a security that is dependent upon or derived from one or more underlying assets. For example, a structured note could derive its performance from the S&P 500 Price Index or the S&P TSX Global Gold Index or numerous others. It can also derive performance from a combination of indexes.
The investment bond element in Structured Notes can be designed to give a return that equals your initial investment, if you keep the product until maturity. The derivative element is designed to offer you the potential to achieve higher returns than a standard deposit.
Investment banks market a Structured Note for their ability to benefit from good stock market performance while simultaneously providing protection against bad market performance. The cost for this protection is covered by modifying the benefit. Unfortunately, the cost of the protection usually outweighs the benefit.
What are the benefits of investing in Structured Notes?
Investment banks typically advertise that structured notes allow you to diversify your investment products and security types in addition to providing asset diversification.
They also advertise that structured notes allow you to access asset classes that were previously only available to institutions or were hard for the average investor to access. (An asset class is a group of securities that exhibits similar characteristics, behaves similarly in the marketplace and is subject to the same laws and regulations.)
Other benefits touted by investment banks:
-possibility of customized payouts and exposures
-possibility of an investment return with little or no principal risk
-some notes offer a high return in range-bound markets with or without principal protections
-some notes declare alternatives for generating higher yields in a low-return environment
Derivatives allow structured notes to align with any particular market or economic forecast. Additionally, the inherent leverage allows for returns being higher or lower than the underlying asset which it derives from.
According to Citibank, structured products can offer you the best of both worlds, combining growth potential, with the ability to protect your initial investment provided they are held till maturity and subject to credit risk of the issuer.
The Downside of Structured Notes
-Pricing is questionable.
Structured notes rarely trade after being issued, so pricing is questionable. Prices are calculated by matrix which means the value is determined by the issuer.
According to PlanSponsor, the investor must take the time to understand how the notes are priced. The fees paid to the issuer and dealer on structured notes can be as little as 40 basis points or more than 100. The fees are difficult to isolate since they are hidden in the bid-ask spread.
At the same time, the average plan sponsor simply does not have the resources to reverse-engineer the more complex instruments to ascertain how they should be priced. The investor who does not call a number of dealers to price the same structure may never know if the pricing is fair.
-Structured Notes are illiquid.
Structured notes cannot easily be sold or exchanged for cash without a substantial loss in value. If for some reason you need to exit early, your only option may be from the original issuer at whatever price they are willing to pay, if any. Structured Note terms are generally between 18 months and six years and it is important that you can afford to tie up your money for that period, because your principal is only protected when Structured Notes are held for their full term.
-There is a market risk with Structured Notes.
Some Structured Notes provide for the repayment of principal at maturity, which is often referred to as “principal protection.” This principal protection is subject to the credit risk of the issuing financial institution. Many structured notes do not offer this feature. For structured notes that do not offer principal protection, the performance of the linked asset or index may cause you to lose some, or all, of your principal, according to an investor alert issued by the SEC. Depending on the nature of the linked asset or index, the market risk of the structured note may include changes in equity or commodity prices, changes in interest rates or foreign exchange rates, or market volatility.
-There is a credit risk with Structured Notes.
Since Structured Notes are an IOU from the issuer, you are left holding the bag if the investment bank forfeits the debt. The protection of principal is subject to the creditworthiness of the issuer. Structured Notes holders may lose up to 100% of their investment upon the bankruptcy of the issuer, even if the value of the reference asset is favorable. The creditworthiness of the issuer may change at any time during the term of the note. Not only are you taking a market risk, but also a credit risk.
– Structured notes may have complicated payoff structures.
It can be difficult for you to accurately assess their value, risk and potential for growth through the term of the structured note. Determining the performance of each note can be complex and this calculation can vary significantly from note to note depending on the structure. Notes can be structured in a wide variety of ways. Payoff structures can be leveraged, inverse, or inverse-leveraged, which may result in larger returns or losses for you.
-Tax treatment can be tricky.
You may wish to consult with a tax advisor before investing in Structured Notes. The tax treatment of structured notes is complicated and, in many cases, uncertain.
Before investing in structured notes, there are several questions you should ask to ensure that you have a clear understanding of the risks and potential returns. Here are some questions you may consider:
Questions to Ask Before Investing in Structured Notes
- What is the underlying asset or index that the note is linked to, and how does it perform?
- What is the maturity date of the note, and what happens if you need to sell it before maturity?
- What is the minimum investment required, and what are the associated fees and costs?
- What is the coupon rate or yield of the note, and how is it calculated?
- What is the credit rating of the issuer of the note, and how does this affect the risk of the investment?
- What is the likelihood of the note being called early, and how would this affect your investment returns?
- What are the potential tax implications of investing in structured notes?
- How does the payoff structure of the note work, and what are the potential risks and rewards?
- Are there any potential conflicts of interest between you and the issuer of the note?
- How does the performance of the note correlate with your overall investment strategy and risk tolerance?
List of Structured Notes in 2023
The White Law Group has been investigating brokerage firms who are improperly recommending Structured Notes to their clients, such as the following:
BNP Paribas 6Y U.S. Equity Autocallable Step-Up Note,
BofA Finance LLC 6Y U.S. Equity Contingent Coupon Callable Yield Note,
Citibank, NA 4Y S&P 500 Daily Risk Control 10% Index Market-Linked CD,
Citigroup Global Markets Holdings Inc. 3Y U.S. Equity Contingent Coupon Callable Yield Note,
Citigroup Global Markets Holdings Inc. 3Y U.S. Equity and Biotechnology Contingent Coupon Callable Yield Note,
Citigroup Global Markets Holdings Inc. 3Y U.S. Equity and Financials Contingent Coupon Callable Yield Note,
Citigroup Global Markets Holdings Inc. 3Y U.S. Equity Contingent Coupon Callable Yield Note,
Citigroup Global Markets Holdings Inc. 6Y S&P 500 Index Autocallable Fully Protected Market Linked Note,
BNP Paribas 3Y U.S. Equity and Energy Contingent Coupon Autocallable Yield Note,
BNP Paribas 3Y Energy and Biotechnology Contingent Coupon Autocallable Yield Note,
BNP Paribas 3Y U.S. Equity Contingent Coupon Contingent Protection Note,
BNP Paribas 3Y U.S. Equity Contingent Coupon Contingent Protection Note,
BNP Paribas 3.5Y U.S. Equity Accelerated Barrier Note,
Bank of Nova Scotia 6Y Euro Stoxx 50 Index Absolute Return Barrier Note,
Barclays Bank PLC 3Y U.S. Equity Contingent Coupon Memory Autocallable Yield Note,
Barclays Bank PLC 3Y S&P 500 Index Contingent Coupon with Memory Autocallable Yield Note,
Barclays Bank PLC 3Y U.S. Equity Contingent Coupon Contingent Protection Note,
Barclays Bank PLC 4Y S&P 500 Index Fully Protected Market-Linked Note,
Goldman Sachs Bank 18M S&P 500 Index Market-Linked CD,
Goldman Sachs Bank 6Y S&P 500 Index Market-Linked CD,
Goldman Sachs Bank 3Y Russell 2000 Index Market-Linked CD,
GS Finance Corp. 3Y U.S. Equity Autocallable Accelerated Barrier Note,
HSBC USA Inc. 4Y U.S. Equity Autocallable Step-Up Note,
HSBC USA Inc. 3Y S&P 500 Index Contingent Coupon Callable Yield Note,
HSBC USA Inc. 5Y U.S. Equity Autocallable Step-Up Note,
HSBC USA Inc. 3Y Nasdaq 100 Index Autocallable Accelerated Barrier Note,
HSBC USA Inc. 5Y U.S. Equity Autocallable Step-Up Note,
Jefferies Group LLC 4Y S&P 500 Index Accelerated Barrier Note,
JP Morgan Chase Financial Company LLC 5Y International Equity Accelerated Barrier Note,
JP Morgan Chase Financial Company LLC 4Y Euro Stoxx 50 Index Buffered Return Note,
JP Morgan Chase Financial Company LLC 3Y MSCI Emerging Markets Index Autocallable Accelerated Barrier Note,
Morgan Stanley Finance LLC 3Y U.S. Equity Contingent Coupon Callable Yield Note,
Morgan Stanley Finance LLC 4Y U.S. Equity Autocallable Step-Up Note,
Morgan Stanley Finance LLC 3Y U.S. Equity Contingent Coupon Callable Yield Note,
Morgan Stanley Finance LLC 4.5Y S&P 500 Index Absolute Return Barrier Note,
Morgan Stanley Finance LLC 4.5Y Dow Jones Industrial Average Fully Protected Market-Linked Note,
Morgan Stanley Finance LLC 4Y U.S. Equity Autocallable Step-Up Note,
Morgan Stanley Finance LLC 5.5Y Dow Jones Industrial Average Fully Protected Market-Linked Note,
Morgan Stanley Finance LLC 5Y U.S. Equity ATM Digital-Plus Barrier Note,
Morgan Stanley Finance LLC 5Y Euro Stoxx 50 Index ITM Digital Barrier Note,
National Bank of Canada 2.5Y U.S. Equity Buffered Return Note,
National Bank of Canada 5Y U.S. Equity Contingent Coupon Autocallable Yield Note,
2023 Raymond James Closed End Fund Series 2 – Class C,
Royal Bank of Canada 5Y S&P 500 Index Buffered Return Note,
Royal Bank of Canada 5.5Y S&P 500 Index ATM Digital Absolute Return Barrier Note,
Royal Bank of Canada 5Y S&P 500 Index ATM Digital Fully Protected Note,
UBS AG 3Y U.S. Equity Contingent Coupon Callable Yield Note,
UBS AG 4Y U.S. Equity Autocallable Step-Up Note,
JPMorgan Chase Financial Company LLC 5Y U.S. Equity ATM Digital-Plus Barrier Note,
BNP Paribas 3Y U.S. Equity Contingent Coupon Contingent Protection Note,
BNP Paribas 4Y U.S. Equity Contingent Coupon Callable Yield Note,
BofA Finance LLC 4Y U.S. Equity Autocallable Step-Up Note,
BNP Paribas 4Y Russell Growth and U.S. Home Construction Autocallable Step-Up Note,
BNP Paribas 3Y U.S. Equity Contingent Coupon Autocallable Yield Note,
UBS AG 3Y JPM Phoenix Autocallable Yield Note with Memory,
Brokers Duty of Due Diligence
Brokers often pitch structured products as providing “downside protection” against losses to a related index while allowing modest upside gain potential. However, investors in Structured Notes are finding out that the protection offered is limited and insufficient to ward off enormous losses.
Brokerage firms are required to perform adequate due diligence on any product they recommend. They must ensure that all recommendations are suitable for their client in light of the client’s age, investment experience, net worth, income, and investment objectives.
If a brokerage firm fails to perform adequate due diligence or makes an unsuitable investment recommendation, the firm can be held responsible in a FINRA Arbitration claim.
Free Consultation with a Securities Attorney
If you suffered losses investing in structured notes with your financial advisor and would like to discuss your litigation options, please call The White Law Group at 888-637-5510 for a free consultation.
The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Seattle, Washington.
Our firm represents investors in all types of securities related claims, including claims involving stock fraud, broker misrepresentation, churning, unsuitable investments, selling away, and unauthorized trading, among many others.
With over 40 years of securities law experience, including experience working at FINRA and the SEC, The White Law Group has the expertise to help investors defrauded in securities, investment and financial business transactions attempt to recover their investment losses.
Although our offices are in Seattle, Washington and Chicago, Illinois, the firm reviews securities fraud cases throughout the country.
For more information on the firm and its representation of investors in FINRA arbitration claims, visit https://whitesecuritieslaw.com.
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